Episode 12: The ICO Ice Age - Back to Banking

Old species are dying and new species are emerging, but perhaps the old ways can’t die because they’re too profitable

“Just for the record, the weather today is calm and sunny, but the air is full of bullsh*t.” — Chuck Palahniuk

Ahhh spring time. The birds are singing, the trees are starting to bloom, and everywhere the ice seems to be melting.

This week, we delve into crypto seasons and how winter isn’t actually winter at all but the dawn of a new age. New species are emerging, and old species are on the verge of going extinct (well, bankrupt). We also do some soul searching and ask — what if the best use case for crypto today is replicating existing market structures?

This week, we finally recorded a video episode. We hope you like the video format!

At its core, interoperability is a social coordination problem, and one of semantics and ideological principles, which makes it challenging to reduce interoperability to a technical problem. This is why people form alliances and coalitions — to resolve social coordination challenges and share in competitive victories through standards development.

In this current market cycle, one of the topics that isn’t getting the attention it really deserves is how trading *actually* works and why interoperability may ultimately be more about market structure and connecting trading networks than it is about connecting blockchain networks. To get there, first we delve deep into the trading lifecycle, and lo and behold, Richard Brown of R3 wrote a great post on the topic back in 2014 when he was still bitcoin-ing and not blockchain-ing. He even talks about colored coins. Swoon!

Today’s crypto market is pretty messy, but more importantly, its largely untethered from the rest of the financial market in every way imaginable. We have our own exchanges, products, standards (like… kind of?), trading venues, OTC desks (who specialize in *only* crypto), data providers, settlement practices, pricing feeds, and everything in between. It’s difficult to get a gauge on actual market activity and market price because much of it is done over the counter (OTC) and manually and lacks any sort of size or scale.

My approximation of the current state of crypto markets. Nifty, right?!?!

Obviously, if we’re talking about markets, we have to talk about market data. If you don’t know about ticker tapes, here’s a great primer on why the tape matters. Yes, we are losers, but Jill Carlson and I were already keenly aware of that when we decided to have salads and record a podcast about ticker tapes on a Thursday at 9 pm. Here’s a great article from 2016 on a push from European market participants for a pan-European “consolidated tape” for bond markets, which also highlights the impact of TRACE on US bond markets. If you want to learn more about TRACE, the Federal Reserve Board (FRB) site has a great piece on US treasury bond trading and trading volume by participant type and order type (electronic v manual).

ANYWAYS — the point of all of that sexy talk about ticker tapes is to highlight the relationships between (1) market structures, (2) trading systems, (3) market standards (via rules and regulations), (4) data and reporting and (5) market participants.

Understanding how the digitization of trading had a massive impact on streamlining the legacy financial market, we can start to form a perspective of where the crypto market might be headed. We’re starting to see these first bridges forming between bitcoin and the legacy market, but it’s only a matter of time before interoperability dictates that crypto markets connect to legacy markets via execution, clearing, and settlement venues as well as reporting standards.

Where interoperability will probably start first — good ol’ bitcoin

Even the DTCC seems to be pushing this issue — since last week they released a white paper and surprise, surprise — they think blockchain-based tokens should use the DTCC to clear and settle. We are absolutely SHOCKED to hear this (said no one actually). As more and more market infrastructure providers get savvy on crypto, more and more of them will also start looking at ways to make crypto and legacy markets interoperable.

And lo and behold, one of the core functions provided by centralized market depositories is the ability to move zeros and ones in a database to reflect ownership. Now, the DTCC doesn’t log every trade the moment it comes in. One of the services it provides is settlement optimization via a process known as netting. Crypto markets are just beginning to embrace netting — see this announcement about “trading from cold storage wallets” which really just means “moving zeros and ones in an internal database and then netting.” Not a criticism, but interesting framing of a narrative legacy markets know well.

One of the more practical outcomes of interoperability is that bitcoin, and eventually all crypto markets, will become more connected to legacy markets, and markets will become more streamlined and orderly as data is consolidated, reported, aggregated, and trading becomes increasingly electronically driven, as opposed to manually driven by today’s OTC desks.

Now this can happen organically, or it can happen through regulation. It only takes a cursory glance at open banking, and this Wired piece provides a great overview of both open banking and the PSD2 regulation in the UK which basically forced the banks to offer up APIs to third party developers.

OK — so back to interoperability. If you missed bitcoin years, crypto actually has its first standards wars via Colored Coins back in 2013 (a great overview from Coin Center). Short summary — Bitcoin figured out digitized assets ie security tokens back in 2013, but there were four competing standards, and as a result the effort sort of… what you’d expect. From CoinDesk, these colored coin protocols were most definitely not interoperable, nor did they really care to be:

Man, I miss the bitcoin only days. People were so direct. ANYWAYS…

At the core of the issue, those firms that embrace interoperability and begin to create the new standards for “interoperability” between crypto markets and legacy markets will have an opportunity to shape how an entire market evolves. It will be contentious. It will be messy. But eventually, all things tends towards consolidation. The question is what shape the long and winding road will take on that path.

Welcome to What Grinds My Gears, a podcast about the world of cryptocurrency. Each week, we delve into one big idea, and examine through a broader financial, political, and cultural lens to learn from the past, understand the present, and explore the future.